President Obama raised…his proposals for tax credits for manufacturers in the United States to encourage the creation of new jobs. He said this was greatly preferable to Mitt Romney’s support for a so-called territorial tax system, in which the overseas profits of American corporations would escape United States taxation altogether. It’s not surprising that large multinational corporations strongly support a territorial tax system, which, they say, would make them more competitive with foreign rivals. What they don’t say, and what Mr. Obama stressed, is that eliminating federal taxes on foreign profits would create a powerful incentive for companies to shift even more jobs and investment overseas — the opposite of what the economy needs.

Since even left-leaning economists generally agree that tax credits for manufacturers are ineffective gimmicks proposed for political purposes, let’s set that topic aside and focus on the issue of territorial taxation.

Or, to be more specific, let’s compare the proposed system of territorial taxation to the current system of “worldwide taxation.”

Worldwide taxation means that a company is taxed not only on it’s domestic earnings, but also on its foreign earnings. Yet the “foreign-source income” of U.S. companies is “domestic-source income” in the nations where those earnings are generated, so that income already is subject to tax by those other governments.

The U.S. system seeks to mitigate this bad effect by allowing American-based companies a “credit” for some of the taxes they pay to foreign governments, but that system is very incomplete.

And even if it worked perfectly, America’s high corporate tax rate still puts U.S. companies in a very disadvantageous position. If an American firm, Dutch firm, and Irish firm are competing for business in Ireland, the latter two only pay the 12.5 percent Irish corporate tax on any profits they earn. The U.S. company also pays that tax, but then also pays an additional 22.5 percent to the IRS (the 35 percent U.S. tax rate minus a credit for the 12.5 percent Irish tax).

Romney is proposing to put American companies on a level playing field by going in the other direction. Instead of immediate worldwide taxation, as Obama wants, he wants to implement territorial taxation.

But what about the accusation from the New York Times that territorial taxation “would create a powerful incentive for companies to shift even more jobs and investment overseas”?

If a company can save money by building widgets in Ireland and selling them to the US market, then we shouldn’t be surprised that some of them will consider that option. So does this mean the President’s proposal might save some American jobs? Definitely not. If deferral is curtailed, that may prevent an American company from taking advantage of a profitable opportunity to build a factory in some place like Ireland. But U.S. tax law does not constrain foreign companies operating in foreign countries. So there would be nothing to prevent a Dutch company from taking advantage of that profitable Irish opportunity. And since a foreign-based company can ship goods into the U.S. market under the same rules as a U.S. company’s foreign subsidiary, worldwide taxation does not insulate America from overseas competition. It simply means that foreign companies get the business and earn the profits.

Getting rid of deferral doesn’t solve any problems, as I explain in this video. Indeed, Obama’s policy would make a bad system even worse.

But, it’s also important to admit that shifting to territorial taxation isn’t a complete solution. Yes, it will help American-based companies compete for market share abroad by creating a level playing field. But if policy makers want to make the United States a more attractive location for jobs and investment, then a big cut in the corporate tax rate should be the next step.

44 Responses

Simply put, to oppose territorial taxation, is to support citizenship tax slavery. Your income belongs to me, do matter where in the universe you live! It is killing U.S. export job creation.

Fortunately for the Chinese, they get the connection and fan out around the world unencumbered by draconian tax reporting and penalty regimes to sell Chinese goods and create export jobs back in their homeland. Americans, mostly stay in Kansas, travel on cruise ships, or sit in tank turrets around the world. Not sure how this helps the U.S. economy.

So awesome to hear you destroy the notion of tax incentives. Would you extend that to oil companies?
“Since even left-leaning economists generally agree that tax credits for manufacturers are ineffective gimmicks proposed for political purposes…”

As a dual citizen abroad I wish the USA move into a residence based taxation for individual taxpayers also. They way the present administration is doing now it is becoming impossible to be an American or Dual Citizen to chose to live and work abroad, even though by doing this they are creating jobs in the mainland. And the great majority of them are not working abroad in order to avoid paying taxes.

Why does Romney not expand territorial taxation to include individuals? In my view, taxing individuals based in residency is far more important than doing so for corporations. I might even vote for Romney if it includes individuals.

I believe that the American idea of “worldwide taxation” is unique to America. Is there any other country which has the arrogance – or do I mean stupidity? – to tax income earned in another country’s territory. “Territorial taxation” is the norm, a policy which helps ensure governments don’t confiscate too much of their citizens’ hard earned income.

So, unless I’m mistaken, it’s America which is out of step with the rest of the world. And this economic disastrous policy, just like Argentine’s economic policies a hundred years ago, will help ensure America’s decline in the world.

Is it willful blindness, or just self sabotage that stops Obama and the apparently economically illiterate from seeing the obvious?

Yesterday, I learned that Raiffeisen, a local bank, refuses to refinance my mortgage simply because I’m considered to be a “US person”. How is Romney’s territorial taxation for corporations supposed to work while US citizens abroad are being denied mortgages, checking accounts, investment accounts or any financial service simply because they are “US persons”?

I vote for “willful blindness”, thus just like the IRS, we can penalize them with the more severe “willful” penalty instead of the “nonwillful” penalty! Although with how the IRS and the Courts are interpreting “willful blindness’ these days, if you don’t have the IRS.gov as your home page on your browser, you are guilty of being “willfully blind” to all the complex tax regulations that ‘may’ apply for you.

Your mission, is to spend the rest of your life looking for the hidden trap just lurking somewhere in the tax code to be sure that you are fully compliant, and if you are not, a non willful or willful penalty will apply. There is no escaping it.

[…] I don’t mention in the video is that a flat tax is “territorial,” meaning that only income earned in the United States is taxed. This common-sense rule is the good-fences-make-good-neighbors approach. If income is earned by an […]

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[…] In an earlier post I argued that U.S. taxation of profits earned outside the U.S. (“worldwide taxation”), causes severe economic damage to the U.S. The U.S. has by far the highest corporate taxes in the world. By far! “Worldwide taxation” creates disincentives to companies bringing their profits back to the U.S. (“repatriating” profits) Imagine if all of this money could be brought back to the U.S. and put to good economic use. Who knows, maybe the government would be encouraged to do so much spending. But, nobody explains this better than Dan Mitchell. […]

[…] thing I don’t mention in the video is that a flat tax is “territorial,” meaning that only income earned in the United States is taxed. This common-sense rule is the good-fences-make-good-neighbors approach. If income is earned by an […]

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